Despite the UK economy gathering pace throughout the course of 2014, it’s been a disappointing year for investors in Dunelm (LSE: DNLM) and Home Retail (LSE: HOME). That’s because shares in the two companies have underperformed the FTSE 100’s modest gains of 1% year to date, with Dunelm declining by 5% and Home Retail falling by 7%. However, could the future be much brighter for the two companies and, if so, which one should you buy?
This week saw both companies release results. In Dunelm’s case, they were full-year results that showed the company increased revenue by 7.8% and earnings per share (EPS) by 9.3%. Furthermore, like-for-like sales improved by 2.1% year-on-year and the company confirmed the opening of 12 new stores during the year, which points to further growth potential. However, any further growth will be spearheaded by a new Chief Executive, with Nick Wharton resigning this week to be replaced by Will Adderley, who was previously his deputy.
Meanwhile, Home Retail’s quarterly trading update was more modest. Like-for-like sales growth was 1.2% at Argos and just 0.1% at Homebase, although perhaps the more important news was that Argos saw its gross margin improve (by 0.25%) for the first time in a number of years. This could prove to be key to the company’s future, since Home Retail is in the process of shrinking its Homebase footprint and only growing Argos’ sales space by 0.2% in the quarter. This means that bottom line growth is likely to come from margin expansion, rather than an increase in total sales.
Although its results were stronger than those of Home Retail, Dunelm’s earnings growth forecasts are in-line with those of its peer. For example, Dunelm is forecast to increase its bottom line by 12% in the coming year, while Home Retail’s earnings are due to rise by 13% this year and by 9% next year. Both of these growth rates are very strong and considerably higher than the mid-single digits that are on offer across most of the UK stock market.
Indeed, what separates the two companies is their valuations. While they both command premiums to the wider market as a result of their strong growth potential, Dunelm trades on a price to earnings (P/E) ratio of 17.2, while Home Retail’s P/E is 15. This puts Dunelm on a price to earnings growth (PEG) ratio of 1.4 and Home Retail on a PEG of 1.2.
While both valuations are attractive, Home Retail seems to have the edge in this space. Furthermore, with Dunelm changing its CEO this week, Home Retail seems to offer more certainty in this key area, as well as equally strong growth rates and a more enticing valuation. While both stocks could be strong performers, Home Retail seems to be the better buy right now.
Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.